Investors might be undervaluing an entire segment of the stock market, and it could lead to a decade of outperformance. The S&P 500 has been hitting new all-time highs in 2024, driven largely by big tech stocks. However, a significant valuation gap between large-cap and small-cap stocks suggests that smaller companies could be the next big opportunity for investors.
The forward price-to-earnings (P/E) ratio of the S&P 600 index is currently much lower than that of the S&P 500, indicating that small-cap stocks may be undervalued compared to their larger counterparts. Historically, when this valuation gap has been wide, small caps have outperformed large caps significantly.
In the early 2000s, during the dot-com recession, small-cap stocks saw massive returns while the S&P 500 struggled. This trend continued through the Great Recession, with small caps consistently outperforming large caps. With the Federal Reserve expected to cut interest rates and recession fears subsiding, now could be an excellent time to consider investing in small-cap stocks.
Investors looking to capitalize on this potential opportunity can consider investing in small-cap index funds such as the SPDR Portfolio S&P 600 Small Cap ETF or the iShares Russell 2000 ETF. Another option is the Avantis U.S. Small Cap Value ETF, which actively selects small-cap stocks based on profitability and valuation criteria.
While large-cap stocks still have their place in a diversified portfolio, the current market conditions suggest that small caps could be poised for significant outperformance in the coming years. By considering small-cap investments, investors may be able to take advantage of a potentially lucrative opportunity in the stock market.
